Security may have been restored to Bahrain’s streets, but confidence has not.

“Look around,” says an opposition activist. “They say security has been restored, but the streets are deserted as no one feels secure.”

Malls and restaurants in the capital Manama are still quiet since protesters took over much of the city in mid-March, before being beaten back by security forces. The Formula One Grand Prix has been cancelled, along with several other tourism boosting events.

“There is no doubt that business has been affected,” says Jonathan Morris, chief executive of UK lender Standard Chartered’s Bahrain operation. “Customers are not buying cars or houses, companies are not investing. Some major malls had been inaccessible for days.” Since 20 March security has been re-established, but with little sign of growth. “Flows are returning and retail volumes are returning to the same level as last year,” adds Morris.

Battered image

Much of Bahrain’s recent economic success has come from promoting itself as a well-regulated, low tax hub for international businesses. Brad Bourland, economist at Saudi Arabia’s Jadwa says Bahrain’s financial sector, a key pillar of the economy, may not be able to overcome the events of the past few months. “Lebanon lost its status as a finance hub in the 1970s and never got it back and Bahrain will probably be the same.”

“The ‘business friendly’ image has taken a battering over the past few months”

Head of a local bank

‘Business friendly’ has been its international marketing image for the past few years. “Undoubtedly, the ‘business friendly’ image has taken a battering over the past few months,” says the head of a local bank. “Once shattered, confidence is a very difficult thing to restore.”

The government must restore confidence if it is to get the economy moving again. The UK’s HSBC has revised down its forecast for Bahrain’s growth to zero in 2011. It expects the country’s economy to grow by 2-3 per cent next year. Others are more optimistic. The Washington-headquartered IMF is predicting growth of 3.1 per cent in 2011 after cutting its earlier forecast of 4.5 per cent growth. But the consensus is well short of the government’s target of about 4.5 per cent growth.

The government admits that growth has been hit by the events of the past two months. “We are still assessing the impact of the recent events on overall growth,” says Rasheed al-Maraj, governor of the Central Bank of Bahrain. “It would obviously be unrealistic to suggest there has been no impact, but we expect a strong rebound in the second half of the year.”

The main driver of that return to economic growth will be a government stimulus package, due to be unveiled in May. The stimulus will be funded by the GCC countries, with the majority coming from Saudi Arabia, which has strong diplomatic ties with Bahrain.

Stimulus support

The GCC has said it will give Bahrain $10bn over the next 10 years as part of the Gulf Development Programme, an aid package that will also involve giving the same amount to Oman to help shore up the other Gulf country that has been hit by destabilising protests.

For Bahrain, getting the money in place and kick-starting the economy through state spending is essential. Once the state begins to spend the money, the trickle down through the economy is expected to be quick.

“It doesn’t take long before the sort of stimulus the government is planning filters through the economy, right down to credit card debt and consumer spending,” says a local banker.

King Hamad bin Isa al-Khalifa has also ordered the creation of 20,000 new jobs. Achieving that target will be difficult, especially as the government has been sacking those people linked to the protests at the same time as promising to create more jobs.

Although a lot of jobs will be created by the infrastructure spending that the government is planning to push ahead with, not many of them will be for Bahrainis. Instead much of the construction work will be carried out by cheap labour from the Indian sub-continent.

The stimulus package is due to start hitting the streets from the second half of the year, with spending due to concentrate on social housing projects, education, healthcare, the redevelopment of Bahrain International airport, and maybe projects by Bahrain Petroleum Company and Aluminium Bahrain.

Finance Minister Sheikh Ahmed bin Mohammed al-Khalifa says he still thinks the target growth rate of 4.5 per cent is achievable. A major part of hitting that target will be pushing ahead with the 2011-12 budget, he adds. Funding that budget will now have to come from the GCC aid package. Bahrain dropped plans for a bond issue of about $1bn as a crackdown by security forces on protests made headlines around the world.

The GCC funding will not only fill the hole left by cancelling the bond issue, but will also leave some extra cash left over. Sheikh Ahmed says the funding will result in “an annual surplus of almost BD377m to the project expenditure budget throughout the next 10 years”.

Rising oil and aluminium prices will also help improve the governments’ finances. The budget is based on an oil price of about $80 a barrel. Although the GCC funding will help Bahrain push ahead with planned infrastructure spending, it will do nothing for the government’s drive to become self-sufficient.

Ratings downgrade

Ratings agencies have downgraded Bahrain by two notches as a result of the protests. “In our view, the downgrades were premature,” says Al-Maraj. “We believe the downgrades in Bahrain’s rating were unjustified given the kingdom’s strong economic fundamentals and the support that we enjoy from the rest of the GCC.”

The government is understood to be planning a series of targeted debt repayments over the next six to 12 months intended to ensure a one notch ratings upgrade. Getting a second upgrade will be difficult as it will be more associated with the increased perception of political risk and the lingering sectarian tension in Bahrain. By early next year, or maybe even before then, the government is expected to try and tap international bond markets again. Until then it could also launch local currency sukuk, like the BD200m ($530m) deal completed in April, to help top up its finances.

Once it has succeeded in getting a ratings upgrade and the sovereign credit default swap rate (CDS), a measure of the cost of insuring debt against default, has fallen further, the government is expected to look again at launching an international bond issue. Bahrain’s CDS rate spiked from around 180 basis points at the beginning of January, to nearly 350 basis points as Saudi troops rolled across the causeway into Bahrain. It has since started to fall back, but the government is expected to wait for a further decline before launching a bond issue as higher CDS rates mean higher borrowing costs.

While the GCC cash will help Bahrain keep its economy going in the short term, the longer term issue will be whether Bahrain can rescue its reputation and attract private investment.

Projects in Bahrain are expected to be delayed as banks and investors wait to see how this crisis plays out before deciding whether to commit to the country. Sheikh Ahmed says the government has not been deterred from its plans to develop projects through a public-private partnership (PPP) route, a key pillar of helping improve the government’s budget.

“Proceeding with the implementation of the Government privatisation strategy, whether through share issue, asset sale, outsourcing or PPP, is helping to relieve the burden on government spending,” he says.

He also reiterated the government’s support for the Vision 2030 strategic plan, which includes ambitions to further embrace the private sector, improve the education and skills of the Bahraini workforce, and ultimately to double household income.

“We are very happy with the relationship with Saudi Arabia, they do not ask us for things in return for helping us”

Senior government minister

“All the aspirations of the Vision will be met, particularly the triple fundamental dimensions of a robust economic growth benefiting Bahraini citizens, an efficient and effective government, and a just and thriving society,” says Sheikh Ahmed. However, achieving that vision now looks much less assured than it once did. “Prosperity was achievable for Bahrain, but now it will depend on the direction of the reform agenda,” says a diplomat in Manama. “It is unclear if the people running the show will still buy into the Vision 2030, which was very much associated with the Crown Prince.”

“But the question has to be, can the country carry on as it is at the moment? At present, it looks like it will be an unsustainable and an unhappy future.”

Saudi backing

Political and economic prosperity are now more intertwined than ever. It is unclear whether the government hardliners who now appear to be taking a more active role in running the country are convinced by the need for economic reform and associated political reform, or whether they are content to continue in the shadow of Saudi Arabia.

“We are very happy with the relationship with Saudi Arabia, they do not ask us for things in return for helping us,” says a senior government minister.

That may be the case, but it remains unclear how much cash Saudi Arabia is ready to give away to prop up Bahrain’s economy, and the ruling Al-Khalifa family, in the name of keeping wider political reform and the prospect of a Shia-led government from emerging.

Until Bahrain’s credit rating improves, it will have to rely on its neighbours’ benevolence to fund its spending commitments. That will keep the economy going in the short term. The longer-term economic and political reform package still must be delivered for Bahrain to have a prosperous future.